Fresh Economic Thinking Cameron Murray

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Theme music: Happy Swing by Serge Quadrado Music under Creative Commons Licence CC BY-NC 4.0

This is a free preview of a paid episode. To hear more, visit www.fresheconomicthinking.com

Paid Fresh Economic Thinking subscribers can enjoy the audiobook version of The Great Housing Hijack via their favourite podcast app.
Two chapters will be released weekly over the coming months.
Theme music: Happy Swing by Serge Quadrado Music under Creative Commons Licence CC BY-NC 4.0

This is a free preview of a paid episode. To hear more, visit www.fresheconomicthinking.com

Paid Fresh Economic Thinking subscribers can enjoy the audiobook version of The Great Housing Hijack via their favourite podcast app.
Two chapters will be released weekly over the coming months.
Theme music: Happy Swing by Serge Quadrado Music under Creative Commons Licence CC BY-NC 4.0

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What is the marginal cost of producing an extra home? This article gets into the weeds and was prompted by this tweet about where the price of homes comes from.
Price would equal MARGINAL construction cost. Otherwise, there would be an incentive to keep building.But marginal cost exceeds average cost.So P = MC > AC. P-AC is the value of land, often called the site value.
This idea dominates a lot of housing economics. Here’s Harvard Professor Ed Glaeser in the Journal of Economic Perspectives.
…we show that the cost [CM: market price] of Manhattan apartments are far higher than marginal construction costs
Comparing the market price of dwellings to marginal construction costs to claim regulations increase housing costs is the core piece of evidence relied upon to argue about the effects of planning regulations.
Here’s a study from RBA researchers Ross Kendall and Peter Tulip making a similar point. And below is a typical tweet making similar claims.
So what does price is higher than marginal cost even mean?
What’s the marginal cost of extra homes?
Let’s say it costs $1 million to build a five-storey apartment building with 10 apartments, so the average construction cost is $100,000 each (which is AC, or average cost). Before construction, it may be possible to redesign the building and incorporate an eleventh apartment. However, the total construction cost of this design might be $1.2 million, which means that the extra cost, or the marginal cost (MC), of the eleventh apartment is $200,000. It costs $1 million for ten dwellings, but $1.2 million for eleven.
Therefore, all similar apartments in this location, under these cost conditions, should be priced at $200,000, as this is the marginal construction cost of an extra apartment in this building.
If apartments were priced in the market at less than $200,000, it is certainly true that eleven apartments wouldn’t be constructed on this site, as the property owner makes less money compared to building ten apartments. If apartments were priced at $180,000, building ten apartments leaves you with $800,000 after construction costs ($180,000 x 10 minus $1 million), but building eleven leaves you with only $780,000 ($180,000 x 11 minus $1.2 million).
When the number of apartments in a building is unconstrained, it is true that when and if a building is developed, it is optimal to not build any denser than where the marginal cost of adding another apartment to the building equals the market price of an apartment.
But what is not true are the additional claims that a gap between price and marginal cost determines the price effect of regulations on density.
Here are three reasons why.
What’s wrong with this claim?
1. The coastline paradox or Russian doll problem
We have so far only looked at an extra marginal dwelling per site (the marginal dwelling density). But there is also the marginal storey per building (the marginal height), a marginal building in a housing project (the marginal building), and at each location there’s a marginal housing project (the marginal project)!
Within each dwelling, there is also the marginal square meter of extra space (the marginal size), which could come in the form of the marginal bathroom, bedroom, patio space, or extra car park, each with its own marginal cost. There are quality margins as well.
Let’s not forget that there is also the marginal dwelling built per period of time (the marginal absorption rate) to consider, something that is always ignored.
Here’s an illustration of this Russian doll of margins in new housing.
Here’s the first problem. On which of these margins should price equal marginal construction cost?
It can’t be all

It costs $30 billion a year in fees alone and takes 11% of wages as a non-tax compulsory payment from families at the time they need the money most, yet there is no lobby group seeking to scrap the wasteful superannuation system.
Cameron and Jonathan discuss how interest groups sprung up around the super honeypot, and contemplate how to form such an anti-super lobby.
Please leave your comments if you want to be part of such a group!
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Theme music: Happy Swing by Serge Quadrado Music under Creative Commons Licence CC BY-NC 4.0


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Thank you to all my existing paid FET subscribers. You will get the audiobook of The Great Housing Hijack starting later this month via the FET podcast.
Your support helps me do things like a recent debate with Kevin Erdmann about “What makes housing more affordable? Public Investment vs. Market Liberalization”. You can watch it here.
Right now there is a Senate Inquiry into supermarket prices as well as a much more extensive and detailed inquiry by the Australian Competition and Consumer Commission (ACCC).
Supermarkets aren’t my highest priority in terms of the cost to consumers from their conduct (superannuation is far more costly - see here and here). But supermarkets nevertheless comprise a large share of household budgets and directly affect choices in our daily lives.
One dimension of supermarket competition revolves around location choices. Rules around these choices usually involve town planning regulations that seek to cluster retail activities in a hierarchy of locations.
This article is about how town planning rules are used as the basis for often frivolous anti-competitive legal cases, with some detail on a recent case in Brisbane.
But the bigger puzzle is this: Why have supermarkets for so long behaved so anti-competitively compared to other retailers or commercial and industrial businesses?
It might simply be the case that when there are few ways to innovate your product, you innovate on other regulatory margins to outcompete your rivals (see last week’s FET #29 podcast about the electricity pseudo-market).
What else is a supermarket to do to make more money?
A history of taming supermarket behaviour
Look at what has already come out of the initial testimony to the current Senate Inquiry on the topic of preventing competition through location choices.
The questions being put to Metcash CEO Grant Ramage during his session were mostly about land banking by Coles and Woolworths.
In the context of the supermarkets, land banking is a strategy  where they buy up large areas of land across the country even if they don't have plans (or permission) to build a store there, therefore reducing competition.
Mr Ramage was asked about this behaviour by Coles and Woolworths throughout his appearance before the committee, and he agrees that they are engaging in land banking.
Senator Ross Cadell gave an example about land banking in the Hunter Valley in NSW, and Mr Ramage agreed that it was an example, where supermarkets can buy a proxy through a developer, gain the centre, and remove the independence.
Senator Dean Smith followed up with more questions about land banking by the supermarket giants, and Mr Ramage responded that he didn't think it was "overt or obvious".
"It happens under the radar, there is no obligation for the majors to divulge when they acquire property, it's not illegal," Mr Ramage says, adding they notify the ACCC and councils when they see it happening.
But this is not the first time that supermarkets have been in the firing line for their anti-competitive conduct. It seems to be the nature of this industry. Brisbane-based property analyst Ross Elliot notes that a senior Westfield executive told him in the 1990s that “we would object to a competitor moving a plant pot if we thought it was in our interests to do so.”
In that 1990s era, we were equally concerned about such behaviour. Here’s a 1999 review of retail trade practices by supermarkets. It took the view that although there was a lot of consolidation in the sector, there were benefits from economies of scale to consumers. What is interesting to note from a quarter of a century in the future is that the market share of Coles and Woolworths hasn’t changed as much as you would think, up from around 55% to 65% (depending on how you count). But there is now no Franklins supermarket chain and we have A